NetEase 2017 Financial Results Analysis

NetEase 2017 Financial Results Analysis

NetEase (NASDAQ:NTES) had a strong 2017, driven by growth across all segments. The company reported total net revenues of RMB 54.1 billion for the calendar year, up 41% YoY. Net Revenues from the company’s gaming segment were RMB 36.3 billion, up 30% YoY. The increase in gaming revenue was primarily driven by smartphone games such as Fantasy Westward Journey, Onmyoji and the newly launched Rules of Survival.

In addition to strong gaming growth, the company also reported that revenues from its e-commerce, advertising, and email & other segments were up year over year too. Net revenue from e-commerce was RMB 11.7 billion, up 160% YoY. This was primarily driven by growth in the Koala and Yanxuan e-commerce brands. It’s worth noting that NetEase’s gaming segment accounted for 67% of total revenues, a decline from 73% in the prior year due to fast e-commerce growth in 2017.

Net income reached RMB 10.7 billion for 2017 compared to RMB 11.6 billion in the prior year. Whilst gross profit for its gaming segment increased due to higher revenues from self-developed titles, operating expenses were considerably higher due to increased selling and marketing expenses, R&D investments, higher staff-related costs, as well as increased operating expenses related to NetEase’s e-commerce businesses. The company also reported a foreign exchange loss of RMB 448 million in 2017 compared to a foreign exchange gain of RMB 146 million in the prior year.

NetEase Mobile Games

NetEase launched a mobile games division in 2015 and it has soared ever since – becoming the only true competitor to Tencent for mobile games publishing in China. Net revenue from mobile games was RMB 25.7 billion in 2017, up 48% YoY. Mobile games accounted for 70.8% of NetEase’s total gaming revenue in 2017 compared to 61.9% in 2016. Growth was driven by continued strong performance of existing titles as well as the launch of new titles such as Crusaders of Light and Minecraft.

Fantasy Westward Journey continues to be the top performing IP for NetEase on smartphones. Despite only being published for the Mainland China market, the game was the #3 grossing iOS game worldwide in 2017, according to Sensor Tower. NetEase employed content updates and a pan entertainment strategy to drive user engagement and spending. Fantasy Westward Journey was originally launched for PC in 2004 and was adapted for mobile devices in 2015 – and the title has been wildly popular on both platforms all along.

Onmyoji was another strong performer in 2017. The turn-based RPG card battle game launched in September 2016 received a new chapter early in 2017 including a brand new augmented reality (AR) mode. This has allowed the game to continue performing well in China where the Japanese mythology and anime graphical style has made It a hit among ACG (Anime, Comics, Games) fans. Onmyoji is an original IP from NetEase developed with a focus on Japanese mythology studied in Japan by NetEase staff.

In 2017, NetEase embarked on an international quest involving marketing, PR, and launching the game in Japan, South Korea and Southeast Asia, where the game was very popular. The company also launched the game in US and Europe, not just for smartphones, but also on Steam to target the growing number of casual PC gamers. NetEase began utilising a pan entertainment strategy for Onmyoji and has already released official comics and a brand-new game in the series, with plans for a full movie also in the works. The new game in the series is a MOBA spin off based on the Onmyoji IP with the same characters, art and setting as the original game. It’s clear that NetEase is looking to take market share away from Tencent in the MOBA space.

New mobile games were also important in 2017. In the MMO category: Crusaders of Light and Demon Seals. In the simulation game category: The Kingdoms. In the casual game category: Super Smash Toys. In the sandbox category: Minecraft. The company also released a number of licensed games including The Room 3 from Fireproof Games and World of Tanks: Blitz from Wargaming (World of Tanks for PC is licensed to a different operator in China). Whilst traditionally strong in the MMO category, the company has made a number of moves to capture market share in genres where it previously had little or no presence.

NetEase PC Games

NetEase reported PC game net revenue of RMB 10.6 billion, essentially flat compared to 2016. Strong performance from legacy titles was able to offset natural softening after a strong 2016, which saw the launch of titles like Overwatch as well as a new expansion for World of Warcraft. It’s still impressive that NetEase were able to keep PC game revenues at similar levels to last year when most smaller gaming companies reported a decline in PC game revenue.

NetEase maintains a handful of strong legacy franchises that continue to perform well on PC. Games such as Fantasy Westward Journey continue to be among China’s most played games and interoperability with the mobile version means engagement and spend across both versions is extremely high. The company recently announced plans to expand its legacy franchises with a pan entertainment strategy, starting with a TV show for Fantasy Westward Journey.

The company’s other top legacy PC games include New Ghost, Tianxia, Revelation Online, Westward Journey Online II and The Heroes of Tang Dynasty, with the latter two receiving expansion packs this year. Whilst NetEase will continue to invest in its legacy titles, the company also debuted two brand new PC games called War Rage and Justice. War Rage is a large-scale battle simulation game that starting testing in June 2017 whilst Justice is an MMO based on Wen Runan’s famous Wuxia novel that started testing in July.

NetEase’s largest partner is Blizzard. NetEase and Blizzard set up a joint venture in 2008 to operate World of Warcraft in China and recently extended the agreement to 2020. Blizzard launched a new expansion for Hearthstone in China this year and launched the Overwatch League which NetEase participated in by becoming the owner of Shanghai Dragons.

In addition to Blizzard, NetEase also worked with Microsoft and Mojang in 2017 to bring the wildly popular Minecraft to all platforms in China. Minecraft is already extremely popular in China thanks to pirated versions of the game on PC and Mobile. In order to entice existing Minecraft players in China, NetEase created a free to play version of Minecraft with official Chinese servers and a superior user experience. The company also launched a creator program that allowed developers to bring their own content to the Chinese version of the game. To date, the official version of Minecraft has over 60 million registered users in China.

Going all-in on Battle Royale

One big trend that no one could ignore in 2017 was the global success of PlayerUnknown’s Battlegrounds (PUBG). The game sold 30 million units worldwide on PC with over 10 million of those unit sales coming from China alone. After seeing the success of PUBG on PC, NetEase saw a unique opportunity and quickly developed its own battle royale game for iOS and Android, hoping to target the more than 500 million mobile gamers in China. The company launched a battle royale mode in its licensed Terminator 2 game In August 2017 for the mainland China market.

Terminator 2 was a top performer and NetEase built upon this experience to build its own standalone battle royale game, Knives Out, which it launched globally in November 2017. This was the first time that NetEase launched a game globally on the same day and shows that the company was keen to be first to market in the mobile battle royale genre. The company had a total of three battle royale games across all app stores at the end of November 2017 to maximise visibility and reach as many players as possible.

The strategy paid off for NetEase as Knives Out amassed over 100 million registered players and Terminator 2 amassed 80 million registered players. NetEase is currently the market leader for mobile battle royale games and has begun to monetise both titles through in game advertising and an in-game shop. In order to maintain its market leading position, NetEase has introduced a world championship esports event for its mobile battle royale games with teams from Asia, Europe and America competing.

The company plans to go all in on the battle royale genre, starting with bringing Knives Out to PC. In 2018, the company will launch four brand new battle royale games to reach users who are looking for a unique survival experience. One of the battle royale games, called Quantum Special, will have cartoonish graphics and a large open world. Another, called Code Alive, will have MOBA elements and a 2.5D top down graphical style.

Investment in Gaming

Netease’s primary focus on investments and partnerships has been on bringing overseas titles to China in order to grow NetEase’s gaming revenue on the mainland. NetEase is known for the quality of its games and aims to keep that reputation by working with developers or publishers that are known for best in class products. Whilst NetEase continues to focus on this as their primary strategy, the success of some of the company’s games overseas has seen NetEase begin to look at investments and acquisitions of overseas companies to expand its presence and grow revenue outside of China.

Mattel announced on January 30th 2018 that it has entered into a joint venture with NetEase to form a game development studio called Mattel163. The studio will develop mobile games and other content based on Mattel’s brands for release in both the China and global markets. The first game title from the partnership will be based on Mattel’s UNO game and will be released on iOS, Android and Facebook. This marks a change from NetEase’s original strategy of obtaining licenses for China. The company is now directly involved in the development of these games and is focusing on the global market instead of just China.

On February 5th 2018, NetEase held a press event to announce that it was investing RMB 1 billion into an esports ecosystem. The company plans to set up a new department dedicated to esports and hire staff for esports planning, broadcasting, content planning, management and many other areas. The company says it will leverage its battle royale and MOBA games to grow its esports presence globally.

Outlook for 2018

NetEase is already off to a strong start in 2018 with brand new game launches, investments in multiple segments and a new joint venture. 2017 was a year of transition for NetEase. A year that saw the company launch multiple games in multiple brand-new genres. 2018 will see NetEase take this one step further with even more battle royale games, real time strategy games and even a monster hunting game, genres that NetEase had no presence in before. We also will watch for what happens with the esports ecosystem investment.

2017 was the year that NetEase shifted focus from mainland China to the global market with the launch of Onmyoji in America, Europe and Asia. Knives Out was NetEase’s first game to launch worldwide on the same day as China. The joint venture with Mattel will see NetEase co-develop games for a global audience.

NetEase is no longer the China focused, MMORPG game developing company it once was, but rather a global digital entertainment force to be reckoned with.